What would a Brexit mean for investors?

With the UK’s future in Europe to be decided next month, what would its departure mean for investors? Emma Cusworth finds out.

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With the UK’s future in Europe to be decided next month, what would its departure mean for investors? Emma Cusworth finds out.

FX volatility around the referendum date is already priced at a five-year high, accordingto SSGA’s Street, but, he warns: “in our view an EU exit is still far from being fully priced in.”

According to Investec Wealth & Investment, several investment banks have suggested mthe pound could lose between 10% and 15% in the event of a Brexit.

The simplest way to hedge for this risk is to mbuy puts in sterling, but, as Coalface Capital CEO Declan McEvoy points out, “they are very costly, as one would expect”. If an institutional investor has UK liabilities and UK assets, then sterling rate volatility (particularly downside risk) is less of a concern.

“If they have a mix of overseas and UK assets with no FX hedge, then they already have some short sterling exposure so the strategy would be to leave that unhedged for now,” McEvoy says. “If already hedged, the hedges could be lifted (ie sell sterling).

If the fund has non-UK liabilities and UK assets, this is more problematic and some FX hedging would be advised.”

A SILVER LINING

While currency devaluation presents some risks, particularly to those with non-domestic liabilities, this potentially dark cloud has a silver lining. A weaker pound would help, for example, to cushion the blow an ‘out’ vote would have on UK equity prices.

John Wyn-Evans, head of investment strategy at Investec Wealth & Investment, points out that with roughly three-quarters of FTSE 100 revenues and earnings coming from overseas, large UK companies are unlikely to be materially affected by domestic events.

The weaker pound, howeverwould “bolster profits by making exports more attractive and by flattering the translation of earnings booked overseas.”

Any market-wide suppression of prices leading into the vote would therefore be likely to throw up buying opportunities, especially for those who believe the end result will be an ‘in’ vote, meaning business as usual, which would result in a short-term relief rally.

Furthermore, dividends declared in dollars, for example, would also become more valuable, boosting income to pension schemes and, as Rob Davies, partner at Quantum Advisory says: “a risk premium on gilts would reduce liability values – all other things being equal.

“We have great hopes for Brexit,” he says. “What might be bad for the UK in general could be good for UK pension schemes.”

EASING THE PRESSURE ON LIABILITIES

An ‘out’ vote would raise the level of general business and economic uncertainty, not least because the threat of capital flight in the form of lower foreign direct investment (FDI) would weigh on the UK’s already sizeable current account deficit. In 2014 the stock of inward FDI was £1trn, 57% of GDP, with Europe accounting for the largest portion of investment.

Hermes’ chief economist, Neil Williams, believes a threat to the UK’s free access to EU markets would “surely risk reducing this inflow and divesting some of the stock”.

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